S7 E04: Debt Traps

Because understanding and managing debt is easier when you know your options and you have the right guidance.

Far too many people get caught up in sneaky and predatory spending cycles that can see them rapidly fall deep into debt, and sometimes these situations can be avoided. Ilan, thanks for being here today.

And happened to fall into doing a bit of consumer work, and that's sort of where I've now focused and moved my career towards, purely-- well, primarily consumer and small business restructuring, working with and trying to help individuals that are struggling with their debt and financial situations.

And there are so many times I've hear from individuals, I should have done this many years ago. I should have known about this many years ago. Why don't we know about these options and programs? It all sounds too good to be true until they really get into it. And you just see that reward that comes out of that. DORETTA THOMPSON: That must be so-- really satisfying. You read that the average person, when they get into trouble with debt, waits for five years before reaching out for help.

And you can just think about the pressure that puts on people. Yeah. I think it's the standard human response is sweep it under the rug, and hopefully it will go away. People do a lot of research and read about debts not being collected, statutes of limitations. But those don't always play into effect. And there's so long you can run and hide. But eventually, someone's going to force you into a corner where you have to do something to help yourself.

And we do find from what we do, generally, people get to the point of they have no choice and they do it. But they would have told you that they thought about it for a number of months, a year or so. They researched it. They met somebody. They thought they could do it on their own, and realized they couldn't, and they end up coming back. So it's how do we get to these people and help them understand there is that option to, I'd say, relieve them from the debt pressures.

So people are starting to transfer-- there are these good kind of emails you get or posts you get saying, hey, transfer your credit card from your current balance to a low interest credit card. But when you read the fine print, those are only for a short period of time. So you're really just kicking the can down the road.

And so when people get that, and then all of a sudden the interest kicks up, people don't seem to really realize the compound effects of the interest, so how it keeps eating away at the available budget you would or may have in order to do this, you just keep digging yourself into a hole further and further. And we say to people, look at your situation.

So if you start to borrow more money, borrow from one account, putting into lines of credit versus credit cards, these are the signs that you may be falling into these traps. You've exhausted all your credit limit, so you can't go into a bank and borrow more money. Your credit cards are overextended. You're not paying your debts based on your income. So these are the things that we are just sort of seeing that people get themselves into these situations.

And, once again, once they start digging, the hole just gets bigger. It doesn't get smaller unless you're very disciplined.

But what we really want to do is look at them and how they can actually become a trap and what you should be looking for. So let's take a start, which you've already mentioned, credit cards. How can credit cards turn into a debt trap for people?

But at some point, because you're not physically seeing what you're doing-- so you pay-- one day, you buy something on a credit card. The next day you buy another thing. You're not actually seeing these transactions. And therefore, by the time you get to the end of the month you realize you've probably spent more than you could of actually afford to pay off that credit card. So now you're in this cycle of I pay my minimum.

I'm paying just a little bit more than my minimum, but that interest keeps growing and growing and compounding. And I mean compounding is interest upon interest, not just on the actual balance. So it becomes bigger and bigger. And when you're talking credit card debts at anything from 20% to 25% interest rate, you're building that debt even bigger and bigger every month. So being in control of and managing and mindful that you can have-- the credit card is not just a blank slate-- go spend.

And oh, what am I going to do at the end of the month? You have to be very conscious of this from the start. I always say to people, credit cards are a replacement for cash, not a replacement for debt. So if you know you could go put it on a credit card and go back and pay it off, great. Use it. If you say, how am I going to pay this off? Well, you should be thinking twice about putting that on a credit card.

They do push people, hey, do you want more? Do you want more? And the funny thing is-- my dad even said this to me many, many years ago. He says, I can't understand this. I pay my account every month, and I try to get an increase in my limit from the bank, and it's like pulling teeth. Whereas, I got someone he was helping who was notoriously bad at paying the credit card, and the bank just kept increasing their limit.

The banks are doing that for a reason because that's where they're making their money on those interest charges, late fees, penalties. So be very conscious that it's not always a good thing when the bank wants to increase your limits. And then that's within your means.

So I sort of use the example, if you had a $5,000 credit card at a 19% interest rate it's going to take you almost 20 years to pay that off, which is a long time. And it's going to land up adding an additional $5,000 to $6,000 in interest. So that $5,000 purchase is going to land up costing you $11,000 $12,000 over that period of time. Whereas if you add a little extra to that minimum payments of $50 a month, it's going to take you about five years.

And basically, you're going to land up spending an additional $4,000, which is more, but it's still, as you can see from the thing, it's definitely a bigger picture. So minimum payments are good, but be conscious. If you're able to add even a little bit more, then go ahead and do that because that will help you get out of the situation quicker. We now move into missing payments or late on payments, this is where it starts costing a lot more money. So additional fees.

The banks will have the discretion of increasing interest rates if they think you're becoming more and more of a risk and you're not going to be paying that down. Obviously, going to impact your credit bureau, your credit score, which everybody seems to look at and focus on. And some of these cards that have these reward programs, they could start taking those away from you. So these are just the risk factors of when you start missing payments, and it starts costing you more and more money.

And there's-- I know there's something new about these installment payment plans. They used to always, though, be for big ticket items. What's the risk of them now that we're seeing them-- these little installment loans?

So the installment plans are good in the fact that they give you a fixed period to pay it off-- can be three months, a number of years. They do include fees and interest. So you've got to be cautious of that. They're offered by traditional banks. And, as I say, when you go onto websites, certain fintechs are financing these things. But they should really, in my opinion, as you said, use for big ticket item things-- emergency situations.

The interest rates are lower, but they typically don't affect your credit score unless you start missing payments. The biggest issues that we see with these plans is people tend to overspend. So they've got this ability to go spend and buy something and know they only have to pay it later on. So it's really a disguised credit card in a way. Paying back could be difficult to track. And that's the one thing you find is they've spent on this installment plan.

But now if you're not being diligent, or you haven't put up a prepaid payment plan on the terms that you've agreed upon, you're not consciously recording it somewhere where you've got to go in and make the payment, that's where people start getting themselves into trouble because they forget. Our lives are busy. We're so busy running and working and doing things you start forgetting. And that's when these things start hurting people. Because as soon as you start missing, you get the penalties.

You get the interest charges. And it becomes a juggling act at that point in time. The other biggest risk you're going to see with a lot of these installment plans is you're now dealing with two parties if you have an issue with what you bought. So if you bought something on an installment plan and you want to return it, or there's a deficiency with the product, you've got to deal with the retailer before the bank will give you the money back.

Whereas, a credit card, if there's a problem, you can go to the credit card company and deal with it. But here, you've got to get the retailer on side who's got to acknowledge there's something wrong, and then notify the financing company that offered the plan. And, in the meantime, you're still paying for that until you get that matter resolved. So it could become a big headache down the line on trying to juggle and manage all these different parties.

And we all know today, there are a lot-- more people you're getting ahold of are robots than people. So it's even getting more and more difficult to returns and dealing with issues on products. So got to keep those kind of things in mind.

The downfall is it actually eats up the equity in your property. The lender, by giving them security on your property, now has their claws in you. So if there's ever an issue, if you don't land up paying them back, they have their rights. And part of their right could be dealing with your home, or trying to realize on your home to get paid out. If there's a first mortgage holder in place,

it gets a little more difficult. But they still have their claws in you, and you're not getting out of that until you pay them off. The HELOCs are 9 times out of 10, or majority times, variable and linked to the interest rate. And what we're seeing right now is the interest rate has gone up quite a bit over the last year. And what your plan would be, it would be based on the prime rate plus a certain percentage.

So every time the prime rate goes up, your interest rate's going up, and therefore, your payment is going up. So when you went into this HELOC, what we saw with people going in the pandemic where interest rates were so low, they were taking these HELOCs quite large amounts. And now all of a sudden, their payments have gone up $500, $600, $700, $800 a month. And we've all seen a number of reports out there that people are $200 a month away from being in financial trouble. People are struggling.

And the other impact on this is when you took the HELOC two to three years ago, it was based on the value of your house that has now gone down $200,000. $300,000 in certain areas. So you've even gone into more negative equity on your property, and you're unable to pay this monthly HELOC charge. So what are the banks going to do? It's going to be very interesting to see how these things are going to change and evolve, and then what the banks are going to do with that.

Are they going to convert these HELOCs into loans, where you've got to fix-- you've got to pay it back, as opposed to just paying interest? So there's a number of things. We're not sure where the banks are going to go with a lot of these things.

And they've come and they've picked up your vehicle. And now they're going to hold it until you either pay them, or they're going to issue a notice saying, hey, we're going to be selling your vehicle to recover our costs. Generally, higher interest rates, so you've got to be cautious there. And it's short-term repayment terms. They not giving you loans on your vehicles for three, four, or five years. They're generally over a shorter period of time.

And all these sort of blend into the signs of maybe you're in financial trouble, and you need to really start looking at your financial situation.

So when you walk past them, and you see the sign that says $15 for $100, it sounds pretty reasonable. I'm going to borrow $100. In two weeks time, I'm going to pay back $115. But when you really do the maths and the calculation, what perceives to be a 50% interest rate is actually almost 300% interest rate that you're paying on these loans. So very, very expensive. And typically, someone who's going into a payday lender is not just paying it off at the next pay period.

They're typically just rolling over and rolling over. And every time you do that, once again, there's the compounding interest effect. And there's the charges that they put onto it, the extra penalties because they having to roll this over. So it just becomes this spiraling effect. And, to me, I'd say it's like running in quicksand. When you go to the front, you've got energy. But eventually, you just can't move anymore.

So it becomes, once again, the lender of last resort based on the onerous interest rates and costs that you're going to land up incurring over time to repay these lenders.

So you've got to be cautious if you really read the agreement and understand what the overall actual interest is that you're paying on these things. So once again, I say with the payday loans, it looks like you're paying a 15% interest rate. But that's over a two-week period. Whereas, the credit card interest rate's 29%, or even 10%, 15%, that's an annual interest rate. So you're comparing a 1.6 interest rate roughly per month to a 15% interest rate every two weeks.

It makes a big difference when you start breaking it down that way.

So people need to be cautious when they're getting into those, and really asking what they're using it for, and what's the ultimate benefit. And the other thing we're starting to see, especially now with seniors, is a lot of these kind of reverse mortgages, which is specific to people that own homes. But I'm not sure how long-term benefit they are to the individual. Short-term, they're very good. But long-term, I think there's a lot of risk with them.

So the bank's given them a limit of $5,000, and they're consistently sitting on that $5,000 and juggling that month to month. These are the really big signs and red flags we're starting to see that people need to be very conscious and monitor their situations to figure out how far they in the hole they are at.

And that, obviously, starts increasing their debt exposure and getting them more into debt. With that said, also their income is not what it used to be, but the cost has gone up right. So they're on CPP, OAS, but the cost of living has gone up. So this is where they are now forgetting or not paying their credit cards and loans because they need their money to live. So these are the unfortunate and I'd say somewhat out of their control circumstances that they're getting themselves into.

For the younger generation, I would say it comes from really two factors-- them being naive, and also, these get rich quick schemes, or these too good to be true schemes. So I always, when I talk to people I say, you've got to understand spending money has a necessity component, and it has an emotional component. Your emotional component is all your wants-- so what you want versus what you need.

And this is where we've got to be cautious and conscious because those wants and those emotional spendings are getting yourself more and more into trouble, having to have the best new phones, the best new products. So these are the traps that people are falling into in order to feel good about themselves, but spending on their credit cards to feel good about themselves. So it's across the board.

But there are, I'd say, at the two ends, two different causes as to why people are getting themselves into these traps and financial situations.

We have generally two categories of people, as I say-- the unfortunate circumstance, where you had a family loss, or you lost your job, or you got sick, and now you have all this debt because you just couldn't keep up. And then you have the other demographic of, as we said earlier, the bank just gave me the credit card. Why couldn't I use it? And it's that justification that those wants are really needs.

So to me, in my personal practice and the way I do things, I'm very direct and upfront with people in a very sympathetic and empathetic way. But I believe people need to hear the facts. Now, they have to want to hear them. But that's being really upfront and saying, you've got to understand, we're all emotional beings. We shop emotionally. That's why marketing is so good, and it's all based on emotion.

So if you could basically step back and really ask yourself what value is this purchase going to add to me personally, I think you'd come up with a different question. But what I think we're finding, people feel that they're entitled to have all these things. And they justify that want as being a need. And that's a very-- it's really a mental kind of game. I need the new cell phone? Why do you need a new cell phone? Well, I need a new cell phone.

But it's not going to change how you live and do your life and do your work and do-- so that there, I think people are very big into justifying something that maybe they don't really need.

How many people are really talking to their kids about credit cards? It's a piece of plastic that you don't see anything, but you're going to have to pay back. So it's not just a piece of plastic that's free money. So I think it is way too accessible. Even people that we do proposals or bankruptcies for, they call me up a week later say, hey, I got these four applications for a credit card. Well, you've just done a proposal bankruptcy. You can't have a credit card.

But the banks are-- and it's with the same banks that they just did the proposal bankruptcy with. So the banks want people to have this because they make their money not off their purchase, they make it off the interest they charge you on the purchase. So they want people to keep going down that route. So they're going to just keep giving, giving, giving. And it's how money revolves and turns in society.

So all this adding together I think is just going to be a pot that's going to explode at some point. Wages definitely are not going up. So we are starting to see double-digit growth now in people requiring financial help and filing proposals or bankruptcy. So we do believe it's going to be something within the next-- we keep saying this, but this really starts feeling like in the next three to six months, something has to give. People just can't keep going on the way they've been going on.

And they're reporting that people are spending 1.8 times more than they earning. And last year it is 1.7. So we can see that that's just increasing as we keep talking about this. The other biggest concern is 2020, people went into, and they started buying these bigger houses because the interest rates were so low. They mortgaged them. They financed them.

We're coming to that period now where three years in, in a year to two years time, these people are going to have to be renewing those mortgages. Well, I don't think they're going to qualify for these 2%, 3% mortgage rates anymore. Even that's-- going 4% or 5%, you're doubling your payment. So it's going to be a big concern, especially when people are saying we can't even afford to live now. So these are things I think we're going to see happening in the next few months.

Garnishment, people suing people-- that's going to start happening. And I think it's going to become pretty rampant in the market. Not to sound doom and gloom, but I think it's going to become a reality.

They will then transition that into the more aggressive collection calls, handing you over to collection agency, reporting you to the credit bureaus for being delinquent on the payment. And the collection agencies get very aggressive. They get very personal, threatening. They're going to sue. They're going to do all this stuff. They're really doing this to either get paid or paper their files.

Because once they've papered their files, it enables them to start a claims process where they go into-- they create a court document. They start a small claim generally, if it's less than $50,000. And you get a notice that you're being sued. You have a choice at that point. You either defend or you don't. If you don't defend it, or you're unable to defend it, they then get a judgment. Now, that judgment is what holds the key to everything. And that's when they start garnishment.

And garnishment could mean freezing your bank account. So any paycheck that goes into your bank, the bank gets a notice that they have to pay that money over to the financial institution or the lender. On the employer's side is if they have that judgment, they contact your employer and they say, hey, this individual owes us money. Please withhold 20%, 30% of their paycheck and pay it to us. And the employer has no choice. Once that order's there, they've got to do it.

So we're starting to see a lot more of this. And when I talk to people in payroll and HR, they say not only do we have one garnishment per individual, we sometimes have two or three garnishments for the individual. But we have to finish the one before we can start the other because they can't take your whole paycheck. So this is what's happening. So there are processes and mechanisms where we can help and stop those kind of things.

The government also has a mechanism of doing that, but they're a lot more aggressive. They don't have to go to court to sue you because it's all built into the legislation. And all of a sudden, you get this fancy notice saying, hey, we're garnishing you. And they can get to a point of garnishing you 100% of your paycheck. So these are the things we're going to see and start seeing coming forward more now, I think, than ever before.

So it's just something you've got to keep in mind that there is the help for that. And I think it's going to become a big problem for people. There's a study showing that debt and people in debt actually has been costing-- in 2022, has cost organizations almost $40 billion in lost production because people are so stressed. People leave their jobs because they try to run from the debt. So it's a very, very big concern.

And we're trying to figure out how to help individuals dealing with it because they are options in dealing with it.

So really putting that down and having a true, hard look at all that stuff is the first step. If you get to a point where you're saying, OK, I can manage this, then start working with paying down your debts and doing a debt management plan for yourself; dealing with your creditors, whether it's the higher interest rate creditors first, or the lower balance first just to feel good that you've paid off some of that stuff.

If you get to the point where you say, I just can't handle this, that's when you need to start reaching out. You need to look for the options-- what's available out there? And there are a lot of options. There's a government-regulated program that we sort of been alluding to, which is managed by the federal government. The Office of the Superintendent of Bankruptcy oversees it. We're licensed. There are about 1,000 of us across the country licensed to help people with these options.

And we have to give all options. So it's not because you can't just see a licensed insolvency trustee, that is, just do a bankruptcy or do a proposal. We're looking at all options. Do a debt management plan. Go get a new credit card. Go refinance, remortgage. We help people with all of that. The last two are either a proposal or a bankruptcy. And, as I say, we're regulated. We're the only ones regulated to do it. So there's a lot out there.

You visit the Office of Superintendent of Bankruptcy website. You can see who we are and who the people are that can help you. And it's just really you being in control. Don't let your creditors control the situation. Take responsibility, be in control. and be proactive. DORETTA THOMPSON: There's one thing I'd like to ask you about that.

Because one of the other things that people can be subject to is there are services that profess that they can help you improve your credit rating, or they can solve your problems for you. What are the red flags around those, and many of which are absolutely fraudulent, and protect themselves from that, and really make sure they're relying on the right professional help? Yeah. So once again, people need to be aware and conscious themselves that being in debt is very stressful.

And when you're stressed, you're going to be doing or making decisions, or look for the quick, how do I get rid of this quickly? And that's where these nonregulated or professions put out there that they can help you with your debts, and they can get rid of your debt, are going to take advantage of that.

And what you should be looking for is when they're being very aggressive, they're calling you consistently, they're telling you that can help you get rid of your debts, they offer you stuff that's just too good to be true, and they can reduce your debt by 80%. They're looking for you to pay upfront so they can get you into the program. We, as a licensed insolvency trusts, do not charge upfront fees. We actually offer free initial consultations which help people understand what their options are.

We're never going to say to somebody, send us your credit card details or pay us. We actually would never take payment by credit card because, obviously, it doesn't make sense. You're trying to get rid of that. So you've got to be careful. What we do find a lot of the things are-- they say how much credit you still have on your line of credit or your credit card? And the reason they ask you that is they want you to use that to pay them.

So theoretically, you're not paying them because the bank's paying them. But you've got to be cautious there. So these are just the things-- so it's really the aggressive. They actually become like collection agencies-- very threatening. If you don't do it now, the creditors are going to come after you. They're going to sue you, da, da, da. There's a time frame for that to happen. So you've got to be very cautious, very conscious when it sounds too good to be true, and it's too much pressure.

We will never put pressure on people to do something because it's a life decision you're making to either do a proposal or bankruptcy. So those are really the big things that I think people need to look out for and be conscious of.

Please note, the views expressed by our guests are theirs alone and not necessarily the views of CPA Canada. This is a recorded podcast. The information presented is current as of the date of recording. New and changing government legislation and programs may have come into effect since the recording date. Please seek additional professional advice or information before acting on any podcast information.

Be well, be kind, and remember, managing debt is within your power when you're informed, prepared, and diligent.